The question most asked by investors late last year, as Treasury bill yields hovered just above zero was “Where can I go for yield?” followed soon after by “What can I do to protect myself from inflation?”
Q3 2022 hedge fund letters, conferences and more
The answer to the first question is that interest rates area discount rate – the price one pays or the return one gets for accepting risk. They have an inverse effect on the prices of assets. One is thus faced with a metaphysical choice between a large portfolio with crummy interest/dividend payments, or else a smaller one with a higher yield. In other words, be careful of what you wish for.
In 2022, that penny dropped as investors finally got their devoutly desired higher yields, paid for with the savaging of the principal value of their portfolios.
The second question had an equally painful answer to many investors in 2021, the most obvious way to protect against inflation seemed to be the purchase of Treasury Inflation-Protected Securities (TIPS). After all, a TIPS provides a nearly perfectly safe way of paying for inflation-adjusted living expenses, but only when held to maturity.
The rub is that the road to that desired result is often bumpy, and, more importantly, the price paid for that inflation guarantee at maturity can vary widely. What folks who bought TIPS last year and early this year, hypnotized by that inflation protection and seemingly riskless promise of secure future consumption, ignored was that the price paid would be dear indeed if and when the Fed responded to inflation by raising rates. For example, the 30-year TIPS auctioned this February at a 0.125% coupon went for 97.96; as of this writing, that same protection of real consumption in 2052 can be purchased for an inflation-adjusted price of 69.23 (which calculates to a real yield of 1.63%). Ouch. Another way of putting it is that good things often come to those who wait; the losses in long nominal Treasury securities have been similar.
The prices of equities followed a similar path. Just who won and who lost during the annus horribilis of 2022? The most obvious winners were young savers who can now purchase stocks and bonds at much lower prices and at much higher yields and expected returns.
The most obvious losers were the folks who in 2021 reached for yield by extending maturities, or who decided it was a good time to defease their future consumption with TIPS. This is best illustrated at the short end of the nominal Treasury curve: In mid-2021, the three-month yield stood at 0.16%, while the five-year note offered all of 0.29%. In other words, one got 13 bp more yield by extending out 4.75 years.
Read the full article here by William Bernstein, Advisor Perspectives.
